A Very Long Trip to TibetSuccession at the Top

When thinking about the need to do estate
planning, imagine yourself on a trip to Tibet. Then consider  what if the trip never
ended and I never returned? Just as you must consider the impact of your mortality on your
family, you must also consider the impact of your death or incapacity on your business.

Many abhor this dreary subject but it requires
attention. In this issue, the third in our series of newsletters on business succession,
the focus is on planning for the passing of control when a major stockholder or officer
dies or becomes too sick to continue.

Planning for the Passing of Control

Although it can prevent a lot of headaches in the
long run, few business owners have the foresight to have written control agreements
between the founder(s) and the next generation (or underlings) regarding the passing of
control. Control agreements can take a number of forms, and may be called redemption
agreements or buy-sell agreements.

For example, suppose the stock in a family-owned
business is owned by several members of the family and it is the wish of all of them that,
in the event of the death of one of them, the deceaseds stock be kept in the family.
If there is no agreement mandating the sale of the decedents business interest, then
that interest will pass by Will or intestacy (if there is no Will) to "someone."
That "someone" may be an estranged spouse who is not a blood relative of the
family or an out-of-state relative who previously had no contact with the business.

One way of preventing ownership from passing
outside a family or group (say, a group of founders) is to have a redemption agreement
between the current owners of the business. A redemption agreement would provide
that if any one of the family members dies, the business or the survivors, individually,
will buy the interest of the decedent. Such an agreement provides a number of benefits in
addition to keeping the ownership in designated hands.

Such an agreement can create a market for the sale
of closely held stock or partnership interests when there is no other practical way to
sell the interest of a decedent. Often the decedents immediate family members are
not experienced in the business or psychologically ready to carry on the duties of the
deceased owner. Such relatives are often better off with cash than with an interest in a
closely held business.

Financing the Purchase of a Decendents Stock

Life insurance, if it is available at a reasonable
price, can prove invaluable in providing funds to purchase the interest of a deceased
family member/stockholder. Furthermore, it allows the family of a decedent to have cash
rather than an interest in a closely held business for which there is no market.

If insurance proceeds are not available to help
pay for the purchase, few small businesses can pay cash for the entire interest of a
decedent. Promissory notes providing for payments over a period of years may be the
answer. Promissory notes allow the business time to pay for the interest, while giving the
decedents family a binding commitment from the business to pay, usually with
interest added for the time value of the use of money. Such notes can, if agreed in
advance, provide the promissory note holders with information about the business. They may
also forbid the business from selling major assets or reorganizing unless the note holders
are paid in full.

More Benefits of a Redemption Agreement

Mandatory sales agreements can also afford another
benefit  avoiding a fight with the IRS over the value of a decedents interest.
If the decedent has a taxable estate, the price stated in a bona fide redemption
agreement will usually establish the value of the decedents interest for estate
tax purposes. So, in addition to handling immediate problems such as cash flow for the
business and the financial needs of the decedents family, a mandatory sales
agreement, if properly drafted, can help keep the IRS examiners at bay.

What about the duties performed by the deceased
business member? Often, in the event of the death of a colleague, the surviving officers
are doubly burdened. Now, they have to handle more duties and work harder in order to
provide income to the surviving members of the decedents family. Imagine having to
handle a heavier workload while, at the same time, having to deal with a surviving spouse
of a deceased business associate who is demanding cash for necessities!

What if major business owner is not dead but is
seriously incapacitated? Suitable agreements can provide for mandatory purchases of the
interest of a disabled or incapacitated business owner, although such provisions are less
common. There is also insurance available for such disabilities but it is much more
expensive than life insurance.

A careful reader may have noticed that this
newsletter has not addressed one of the toughest issues related to a mandatory sales
agreements -- "How do you set the price?" Thats our topic for next time.

If you are a tax professional and would like more information about the subjects covered in this newsletter or any other tax and business matter, please call the Tax & Business Professionals, Inc. at (800)-553-6613, e-mail us at
, or visit our web site at http://www.tax-business.com.

For a full range of business law and tax-related services, call the law firm of Newland & Associates at (703) 330-0000.

If you are reading this newsletter but are not on our mailing list, and would like to be, please contact us at (800) 553-6613.

While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.

Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.

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